Archive for the ‘ Macroeconomics ’ Category

Yes, Wages are Sticky; No, I’m not a Keynesian

Bryan Caplan believes that sticky wages are partially the product of government intervention, but much more significantly a product of behavioral psychology. He has recently gotten excited about it and challenged anti-keynesians to register their responses to Truman Bewley’s magnum opus on sticky wages with the presumption being that significant and persistent unemployment caused by non-legislatively induced wage stickiness suggests expansionary monetary/fiscal policy as the only reasonable solution. If you’re a GDP fetishist, you’re an interventionist plain and simple, if you oppose involuntary unemployment (lost gains from trade), these facts would seem to recommend intervention as well. I see this as a watershed in the liberty vs. efficiency debate, where the advocates of efficiency break toward Keynes and the advocates of liberty must bear some lost gains from trade to respect the rights of savers, ill-positioned (vis a vis stimulus) businesses, and, most interestingly, the unemployed and those businesses who refuse to hire them at lower wages.

First off, you might be wondering how I think the liberty vs. efficiency debate even applies here. I take liberty to imply both complete freedom to use those resources to which you are entitled and complete responsibility for what comes of those decisions. One thing people are entitled to under any reasonable version of entitlement theory is their psychological disposition, so long as they bear the full cost to themselves and others. The disposition at issue is the common unwillingness to be a reasonably productive worker when you (wrongly) feel you’re being undercompensated. The cost of that disposition to you is “involuntary” unemployment. If I could wish that cost or disposition away so you could rejoin the workforce and add to society’s bounty, I absolutely would. Unfortunately, the Keynesian remedy comes at a greater cost than a passing thought and pair of crossed fingers; it requires a reallocation of resources away from the distribution currently geared toward those who’ve managed to justify their wages and it punishes those people who appreciate the difference between nominal and real wages enough to bid their numbers down without sacrificing productivity (and those who’ve cultivated the willingness/ability to recognize this from a hiring perspective).

The end result? You’ve tricked a relatively undesirable portion of the workforce into thinking they’re worth more than they are by diminishing the real compensation of the relatively productive. And you’ve done all this without the consent of those who’ve borne the cost. There are two inclusive arguments against my point here 1) If the employed had all the relevant information, they’d consent to it because 2) re-employing unutilized resources meaningfully grows the economy and compensates for a very large part of any transfers that took place. Liberty and efficiency!

The first point doesn’t quite measure up: the proposal is a risk and a difficult-to-gauge one at that; surely there’d be plenty of risk-averse wage earners not willing to bear the costs of misallocation and/or inflation. On the second, the size of this compensation is not at all clear, and there are plenty of reasons to doubt it would recoup the social cost. Among these is the fact that, in most cases, businesses have discretion with regard to who gets laid off, and the body of the long-term unemployed population will largely be comprised of low skill/wage ratio individuals. That means higher nominal wage targets will need to be met with more aggressive (inflationary/distorting) stimulus to add some of the most relatively low-productivity workers to (hopefully) relevant/valuable sectors of the new economy. The act itself subsidizes their problematic dispositions, and the results are not obvious boons either.  You’ve just about tricked a handful of people into not being zero-marginal-product workers; not only does this violate liberty, it likely comes well short of clearing the – thoughtfully construed – efficiency bar as well.

Follow the Goods, not the Money: The ‘I Am Rich’ App and its Discontents

A bit late to the party, I recently stumbled upon this story and, more importantly, this response to it. It naturally got me thinking about wealth transfers since the moral and economic consequences of purchasing the ‘I am Rich’ app lend themselves more toward that description than one of proper consumption.* Treating and scorning these purchases as bona fide consumption I think is an instance of a common economic fallacy: following the money.

All exchange is fundamentally the same phenomenon at the micro level: someone values a physical good, service or any psychological consequence that comes of transferring their resources to someone else, so they do it and, if the exchange was voluntary, there is an ex ante increase in utility for both parties. At the macro level, however, it becomes useful to delineate consumption and transfer; the implications for society matter. Pure transfers have no effect on the allocation of resources unless some very specific behavior induced the transfer and would do so predictably in the future. If transfers like this were profitable enough for many prospective recipients, it would soon develop into a market for services, much like I speculate the market for street beggars to be. However, to the extent transfers are not behavior induced or are sufficiently isolated/unpredictable, their effect on the structure of production is precisely a transfer from the marginal consumption pattern of the transferer to the marginal consumption pattern of the transferee with a magnitude of the sum transferred. To call money wasted or opportunities foregone in this instance is inappropriate; it depends on what the recipient will do with his windfall.

In the case of the app, its developer did adjust his behavior to meet some perceived market demand and his minor success may have signaled others to do likewise and, to that extent, it was a humanitarianly wasteful venture. I, however, measure this extent to be quite small in comparison to the money he received given his presumably moderate opportunity costs and very low resource commitment to the project. This was mostly a one-off transfer in my view and its effects on the actual distribution of resources in the world are negligible given the sums involved; their impact was (circa 2008) still yet to be determined. Armin Heinrich can still make the world a better place, and the world has lost very little for his app.

GDP Fetishism is Anti-Economic

While I will never deny that GDP and other measures of national income are useful metrics, I tend to fall in line with the view that economists, and to a greater extent, people in the public sphere greatly overrate its significance. My view is a relatively critical one because 1) there are important goods that GDP leaves out, 2) there are definite wastes and evils that it counts as goods, and 3) there is no mechanism in the calculation of GDP that serves to cancel the effects of 1) and 2).

The goods left out: production for exchange in kind or by volunteers, any untaxed monetary exchange, the cost of work and the value of leisure. I feel I’ve listed these in ascending order, with the latter two being the most significant. I realize that theory dictates the only reason we work is because the utility of consumption outweighs the disutility of having to work for it, but the ambiguous size of the spread between them really does make all the difference.  Still, shouldn’t everything listed above remain relatively stable in proportion to GDP? When GDP shrinks can we assume that any deference to the underground economy only highlights its status as an inferior market? Certainly the preference for leisure is stable…

A sturdier retort to the fetishists hones in GDP inclusion of various evils. In recent years, government spending in the United States has directly accounted for ~20% of GDP. Factoring in transfer payments and Government spending not contributing directly to GDP, and the figure could easily be 40%. My point is not to say that Government = waste, but there are both some clear-cut instances (half the worlds military spending for 4% of its population, mayors’ extended families always see lush parks and smooth roads popping up in their neighborhoods, etc.) and powerful theoretical explanations (No market test, government slack, favor doling) for why we’d expect government to be more wasteful and even destructive than some other parts of the economy. Also, it’s safe to assume that production would be marginally but significantly lower if actors bore the full social costs of production; we could easily slash GDP by making oil companies pay for the right to pollute…

But just as GDP can be slashed by altering our social institutions in a beneficial way, so to can it be increased by altering those institutions in a destructive or wasteful fashion. Whats odd is that this is the basic economic insight into almost anything, but it seems lost on most economists when it comes to GDP: like any good, we face a marginal trade-off between it and other goods. I presume most economists don’t see it the way I do, not because they’re unaware of all the criticisms I raise, but rather because GDP is the best macroeconomic metric they have and the intradisciplinary norm has been to trivialize its shortcomings.

The consequence is that economist regard any increase in real GDP growth as positive and and decrease as catastrophic. What an unbiased analysis should show is that their are times when GDP grows too quickly and the public has inefficiently shifted their resource allocations away from leisure/non-monetary exchanges/risk-aversion and towards frivolous consumption/investment. In most introductory macro classes, students are taught to fear the “contractionary spiral:” Mike gets laid off, he can’t spend as much at the bakery, so they lay off Juan, who can’t spend as much somewhere else and so on until we’re all paupers. Never discussed is the “expansionary spiral:” Mike thinks his assets will appreciate rapidly in perpetuity, thinking he will be rich forever, his willingness to pay leads him to spend far more than he would otherwise; consumer prices are bid up, followed by factor prices, wages and asset values rise more rapidly, more people feel like Mike. Eventually the market finds a highly leveraged equilibrium and only a small decrease in the speed of the spiral growth will send it all crashing down, leaving people worse for wear and deferring to less preferred consumption, i.e. leisure, barter, etc.

So it turns out GDP is just as easy to manipulate as macroeconomists believe it is. The problem is that GDP has been interpreted as prosperity itself, rather than an indicator of it, largely because few see a problem with the expansionary spiral if only it can be kept going. Unfortunately, in real terms, such a spiral will eventually make leisure (foregoing the disutility of producing) too cheap, and once people start to cash out of the spiral and into happiness, the instability of the thing is revealed. As far as assessing the state of the economy goes, it’s truly an exercise in knowing the current trade-off between measured and unmeasured activity. There’s no doubt that real GDP per capita growth should be the norm, but at what rate is very unclear if you’re not taking sides; 1% per year is well below out running average, but would still see the average person’s income double in the course of one lifetime. As with every decision, quality matters. We can’t just aggregate people’s decisions and say the more the merrier when there may be a lot left on the table.